A perfectly competitive market has a very large number of relatively small buyers and sellers.
- The product is homogeneous.
- There is free entry and exit in the industry.
- Every firm’s action is independent of the other firm.
- In this market there is perfect mobility of factors.
- The sellers operate in conditions of certainty having complete knowledge of costs, demand, price and quantities.
Equilibrium of the firm is attained where Marginal revenue is equal to marginal cost, i.e., MR=MC (MC curve cuts the MR curve from below).
If a firm in a perfectly competitive market raises the price of its product above the going price, then it will not be able to sell its products. Therefore, each firm is insignificant. Also, the firm is not able to earn profit by cutting the price because it can sell any quantity of goods at the going rate.
When faced with competition, all the firms sell their product at the same price. The average and marginal revenues would be consistent and equal.
The firm should adjust its output in relation to the prevailing price so that it could maximize its profit. The entry or exit is not possible in the short run, so the firm may either earn a profit or suffer a loss in the short run.
In the long run, the firms operating in the market are free to enter or exit. So, if there is a situation of profit, new firms would enter the market and compete with existing firms. Supply would increase and price would shift downwards, thus eliminating the excessive profit. However, if there is loss, some firms would exit, there would be shortage and supply would decline leading to an upward shift in the price, thus elimination in the losses.
Price is determined at a point where the demand of a commodity equals its supply. The determination is different in different time periods i.e. very short run, short run and long run.
a) Price Determination In Very Short Run
• Supply of commodity is fixed.
• Input supply is fixed
• The demand varies and determines the price.
• For perishable goods, the entire supply has to be sold at the earliest and for durable goods, this is not the case.
• For durable goods, supply can be adjusted with demand accordingly.
b) Price Determination In Short Run
• The firm can change its supply by changing the variable factors.
• The firm is not in a position to change the scale of its plant.
• Also supply can be changed to a limit as per the capacity of the firms.
• The number of firms can neither increase nor decrease in the short run.
• An increase in demand will lead to a rise in both quantity and price and vice versa.
c) Price Determination in the Long Run
• In the long run, it is possible to change the supply.
• Shift in demand takes place with greater adjustment in supply and smaller adjustments in price.
• It is not necessary that the new price would go in the same direction as the demand.
• The new price may be equal to, less than or more than the initial price and this depends on the industry cost conditions.
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